way of an IPO, such that Entity A loses control over Entity X and Entity Y, does this mean that common
control is ‘transitory’?
In our view, the answer is ‘no’. Common control is not considered to be transitory and therefore the
reorganisation is excluded from the scope of IFRS 3. This is consistent with the ordinary meaning of
‘transitory’, i.e. something which is fleeting, brief or temporary. The common control of Entity X and
Entity Y was not fleeting in the fact pattern as both entities had been controlled by Entity A for several years.
In contrast, if Entity Y had only recently come into the group, this may well indicate that control is transitory.
Although Example 10.2 above involves a newly formed entity, the same considerations
apply regardless of how the reorganisation may have been structured prior to the IPO.
For example, Entity X may have acquired Entity Y or the net assets and trade of
Entity Y, with Entity X then being subject to an IPO. In such a situation, Entity X would
apply the scope exclusion for business combinations under common control.
3
ACCOUNTING FOR BUSINESS COMBINATIONS
INVOLVING ENTITIES OR BUSINESSES UNDER COMMON
CONTROL
IFRS 3 prescribes a single method of accounting for all business combinations that are
within its scope, i.e. the acquisition method. No other methods are described and the
standard does not address the appropriate accounting for business combinations under
common control excluded from its scope. The ‘pooling of interests’ method and ‘fresh
start’ method are only referred to in the Basis for Conclusions as possible methods of
accounting, but were not deemed appropriate for all business combinations. [IFRS 3.BC23].
The discussion below considers how entities should account for business combinations
under common control outside the scope of IFRS 3 (described at 2 above). If the assets
acquired and liabilities assumed do not constitute a business, the transaction is
accounted for as an asset acquisition. The accounting for acquisitions of (net) assets
under common control is discussed in Chapter 8 at 4.4.2.D. In addition, transfers under
common control involving a Newco are considered separately at 4 below.
Legal mergers between a parent and its subsidiary are discussed in Chapter 8 at 4.4.3.B.
3.1
Pooling of interests method or acquisition method
IFRS 3 scopes out business combinations under common control and is not prescriptive
otherwise as to the method of accounting for such transactions. Entities should
therefore develop an accounting policy that results in relevant and reliable information
by applying the hierarchy in paragraphs 10-12 of IAS 8 – Accounting Policies, Changes
in Accounting Estimates and Errors (discussed in Chapter 3 at 4.3).
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Applying that hierarchy, entities may refer to IFRS 3 as a standard that deals with a
similar and related issue, and apply the acquisition method by analogy. Entities may also
consider the most recent pronouncements of other standard-setting bodies having a
similar framework to IFRS, other accounting literature and accepted industry practices,
to the extent that these do not conflict with any IFRS or the Conceptual Framework for
Financial Reporting (Conceptual Framework). Several standard-setting bodies have
issued guidance and some allow or require a pooling of interests-type method (also
referred to as ‘predecessor accounting’, ‘merger accounting’ or ‘carry over accounting’
in some jurisdictions) to account for business combinations under common control.
Accordingly, we believe that a receiving entity accounting for a business combination
under common control should apply either:
(a) the acquisition method set out in IFRS 3 (see 3.2 below); or
(b) the pooling of interests method (see 3.3 below).
We do not consider that the ‘fresh start’ method, whereby all assets and liabilities of all
combining businesses are restated to fair value, is an appropriate method of accounting
for business combinations under common control.
However, in our view, this accounting policy choice is only available if the transaction
has substance for the combining parties. This is because the acquisition method results
in measuring the net identifiable assets of one or more of the businesses involved at
their acquisition-date fair values and/or the recognition of goodwill (or gain on a bargain
purchase). IFRS contains limited circumstances when net assets may be restated to fair
value and prohibits the recognition of internally generated goodwill. A common control
transaction should not be used to circumvent these limitations. Careful consideration is
required of all facts and circumstances, before it is concluded that a transaction has
substance. If there is no substance to the transaction, the pooling of interests method is
the only method that may be applied to that transaction. If there is substance to the
transaction, whichever accounting policy is adopted, should be applied consistently.
Evaluating whether the transaction has substance will involve consideration of multiple
factors, including (but not necessarily limited to):
• the purpose of the transaction;
• the involvement of outside parties in the transaction, such as non-controlling
interests or other third parties;
• whether or not the transaction is conducted at fair value;
• the existing activities of the entities involved in the transaction; and
• whether or not it is bringing entities together into a ‘reporting entity’ that did not
exist before.
The concept of ‘reporting entity’ is clarified in the revised Conceptual Framework
(which was issued in March 2018 and is discussed in detail in Chapter 2). A reporting
entity is described as an entity that is required, or chooses, to prepare financial
statements. This can be a single entity or a portion of an entity or comprise more than
one entity. A reporting entity is not necessarily a legal entity. [CF 3.10].
Business combinations under common control 717
Example 10.3: Accounting for business combinations under common control –
use of acquisition method? (1)
Entity A currently has two businesses (as defined in IFRS 3) operated through wholly-owned subsidiaries
Entity B and Entity C. The group structure (ignoring other entities within the group) is as follows:
Entity A
Entity B
Entity C
Entity A proposes to combine the two complementary businesses (currently housed in two separate entities,
Entity B and Entity C) into one entity, in anticipation of spinning off the combined entity by way of an IPO.
Both businesses have been owned by Entity A for several years. The reorganisation will be structured such
that Entity C will acquire the shares of Entity B from Entity A for cash at their fair value of £1,000. The
carrying amount of the net assets of Entity B is £200 (both in the individual financial statements of Entity B
and in the consolidated financial statements of Entity A). The net of the acquisition-date fair values of the
identifiable assets acquired and liabilities assumed of Entity B (measured in accordance with IFRS 3) is £600.
How should this transaction (to facilitate a subsequent spin-off) be accounte
d for in the consolidated financial
statements of both Entity C and Entity A?
As far as Entity C is concerned, there is a business combination that needs to be accounted for. That business
combination is however excluded from the scope of IFRS 3, as it is under common control and that control not
transitory. In this fact pattern, there is substance to the transaction. There is a business purpose to the transaction;
it has been conducted at fair value; and both Entity B and Entity C have existing activities. Accordingly, Entity C
can apply either the acquisition method as set out in IFRS 3 or the pooling of interests method in its consolidated
financial statements. The selected accounting policy should be applied consistently to similar transactions.
If Entity C selects the acquisition method, it will need to identify whether Entity C or Entity B is the acquirer
(see 3.2 below). Assuming that Entity C is identified as the acquirer, in summary, this will mean that the net
identifiable assets of Entity B will be initially reflected at their acquisition-date fair values (£600), together
with goodwill of £400 (£1,000 less £600), in the consolidated statement of financial position. Only the post-
acquisition results of Entity B will be reflected in the consolidated statement of comprehensive income.
As far as Entity A is concerned (i.e. from the perspective of the controlling party), there has been no change in the
reporting entity – all that has happened is that Entity B, rather than being directly held and controlled by Entity A, is now indirectly held and controlled through Entity C (i.e. no change in control). Accordingly, there is no business
combination and any accounting consequences are eliminated in full. Thus, the carrying amounts for Entity B’s net
assets included in the consolidated financial statements of Entity A do not change. There are also no non-controlling
interests (NCI) affected. The transaction therefore has no impact on the consolidated financial statements of Entity A.
In Example 10.3 above, Entity C had to account for its business combination with Entity B,
as it was preparing consolidated financial statements. In some situations, Entity C would not
need to account for the business combination at all, as it may be exempt as an intermediate
parent company from preparing consolidated financial statements (see Chapter 6 at 2.2.1). If
in Example 10.3 above, Entity C had acquired the business of Entity B, rather than the shares,
then the same accounting policy choice would have to be made for the business combination
in Entity C’s financial statements, even if they are not consolidated financial statements.
However, in other types of reorganisations, careful consideration of the factors above
may indicate that there is no substance to the transaction. This is illustrated in
Example 10.4 below by transaction (ii).
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Example 10.4: Accounting for business combinations under common control –
use of acquisition method? (2)
Entity A engages in different business activities in two geographical areas through four wholly-owned
subsidiaries (all owned for several years). Each subsidiary individually meets the definition of a business in
IFRS 3. Traditionally, the legal structure followed the geographical areas of operations. To align with its
management structure, which is organised by business segment, Entity A proposes to reorganise its legal
structure. This two-step process involves (i) Entity B distributing its shares in Entity D to Entity A, and (ii)
Entity D acquiring the shares in Entity E. The transaction price for (ii) reflects the carrying amount of
Entity E’s net assets as included in the consolidated financial statements of Entity A. The group structure
before and after this reorganisation is as follows:
Before
Entity A
Entity B
Entity C
Entity D
Entity E
After
Entity A
Entity B
Entity C
Entity D
Entity E
How should this transaction (to align the group’s legal and management structure) be accounted for in the
consolidated financial statements of both Entity A and Entity D?
As far as Entity A is concerned, neither its own acquisition of the shares in Entity D (by way of distribution
from Entity B) nor the transfer of shares in Entity E from Entity C to Entity D represents a business
combination. As described in Example 10.3 above, from the perspective of the controlling party, there is no
change of control. Because there is also no NCI affected, the reorganisation has no impact on the consolidated
financial statements of Entity A.
In contrast, in the consolidated financial statements of Entity D, there is a business combination that
needs to be accounted for. That business combination is however excluded from the scope of IFRS 3,
as it is under common control and that control not transitory. In this fact pattern, while Entity D and
Entity E have existing activities, there is no substance to the transaction. There is no clear business
purpose to the transaction; the restructuring is purely internal, with no external parties being involved;
and the transaction is not conducted at fair value. Consequently, Entity D cannot apply the acquisition
method in its consolidated financial statements. This reorganisation will be accounted for using the
pooling of interests method.
Business combinations under common control 719
In Example 10.4 above, Entity D had to account for its business combination with
Entity E, as it was preparing consolidated financial statements. In some situations,
Entity D would not need to account for the business combination at all, as it may be
exempt as an intermediate parent company from preparing consolidated financial
statements (see Chapter 6 at 2.2.1). If in Example 10.4 above, Entity D had acquired the
business of Entity E, rather than the shares, then the business combination would
similarly have to be accounted for using the pooling of interests method in Entity D’s
financial statements, even if they are not consolidated financial statements.
3.2
Application of the acquisition method under IFRS 3
The application of the acquisition method is set out in IFRS 3 and discussed generally
in Chapter 9. This method involves the following steps:
(a) identifying an acquirer (see Chapter 9 at 4.1);
(b) determining the acquisition date (see Chapter 9 at 4.2);
(c) recognising and measuring the identifiable assets acquired, the liabilities assumed,
and any non-controlling interest in the acquiree (see Chapter 9 at 5); and
(d) recognising and measuring goodwill or a gain on a bargain purchase (see Chapter 9 at 6).
[IFRS 3.5].
As far as (a) above is concerned, it may be that in some cases the identification of the
acquirer means that the business combination needs to be accounted for as a reverse
acquisition (see Chapter 9 at 14). Careful consideration is required where the business
combination under common control involves a Newco, as it may be a high hurdle for a
Newco to be identified as the acquirer under IFRS 3 (see 4 below).
As far as (d) above is concerned, goodwill at the acquisition date is computed as the
excess of (a) over (b) below:
(a) the aggregate of:
(i)
the consideration transferred (gene
rally measured at acquisition-date fair value);
(ii) the amount of any non-controlling interest in the acquiree; and
(iii) the acquisition-date fair value of the acquirer’s previously held equity interest
in the acquiree.
(b) the net of the acquisition-date fair values (or other amounts recognised in
accordance with the requirements of the standard) of the identifiable assets
acquired and the liabilities assumed. [IFRS 3.32].
Where (b) exceeds (a), IFRS 3 regards this as giving rise to a gain on a bargain purchase.
[IFRS 3.34].
The requirements of IFRS 3 in relation to the acquisition method have clearly been
developed for dealing with business combinations between parties transacting on
an arm’s length basis. The consideration transferred in a business combination at
arm’s length will generally be measured at the acquisition-date fair values of the
assets transferred, liabilities incurred and/or equity interests issued by the acquirer
(see Chapter 9 at 7). The fair value of that consideration will generally reflect the
value of the acquired business. For business combinations under common control,
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however, this may not be the case. The transaction may not be at arm’s length and
the fair value of the consideration transferred may not reflect the value of the
acquired business.
Where a higher value is given up than received, economically, the difference represents
a distribution from the receiving entity’s equity. Conversely, where a higher value is
received than given up, the difference represents a contribution to the receiving entity’s
equity. Nevertheless, IFRS neither requires nor prohibits the acquirer to recognise a
non-arm’s length element in a business combination under common control. If such
transaction is not at arm’s length, this may suggest that there is no substance to the
transaction and application of the acquisition method might not be appropriate (see 3.1
above). If, however, the acquisition method is appropriate, in our view, the receiving
entity may either:
(a) recognise the transaction at the consideration transferred as agreed between the
parties (measured at the acquisition-date fair value in accordance with IFRS 3); or
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 142
